Employee versus Independent Contractor

“The difference between slaves in Roman and Ottoman days and today’s employees is that  slaves did not need to flatter their boss.”
 – Nassim Nicholas Taleb, BS, MS, MBA, PhD is a scholar, statistician, and author of the book, “The Black Swan”

sweatshop

Written by Steve Nyvik, BBA, MBA, CIM, CFP, R.F.P.
Financial Planner and Portfolio Manager, Lycos Asset Management Inc.

 

The exploitation of labor conjures up images of workers laboring in sweatshops for 12 hours or more a day, for pennies an hour, driven by a merciless overseer.  Employment in Canada has evolved – some might argue just enough to keep abreast of changes in provincial employment standards, where the payer offers low wages and has control over how you work.

When starting one’s career, one likely has to take whatever they can to make money and to gain work experience.  But for highly educated or experienced workers, there exist some types of work where the payer doesn’t control every aspect of what to do and how to do it.  It is in these types of roles where respect and satisfaction are more likely to be found and where one is treated as a professional.

Where one can be considered as an independent contractor, such status can come with valuable tax benefits of being able to deduct a wide range of business expenses and taxable income being subject to the small business tax rate (for 2016, the combined federal and BC corporate tax rate on the first $500,000 of active business income is 13%).

So, if you are the type of person that wants to be in business as opposed to working for someone, let’s look at some of the obstacles you’ll need to navigate.

 

Personal Services Business

To be able to claim a wide range of business expenses and enjoy the small business tax rate, your business cannot be considered to be a Personal Services Business (“PSB”) under 125(7) of the Income Tax Act.

A Personal Services Business carried on by a corporation in a taxation year means a business of providing services where:

  • an individual who performs services on behalf of the corporation (an “incorporated employee”), or
  • a person related to the incorporated employee

is a specified shareholder (i.e. owns 10% or more of the company) of the corporation and the relationship between the provider of the service and the entity receiving the service could reasonably be regarded as an employee/employer relationship.

As most consultants will own more than 10% of their company, the issue is that of whether you are in an employee / employer relationship.

 

Are you an Employee or Independent Contractor?

There is no one, definitive test of whether a worker is an employee or an independent contractor.  Such a determination requires consideration of a wide variety of factors and each situation requires an independent assessment.  The key is determining whether the worker is performing services as a person in business on his or her own account or as an employee.

The Canada Revenue Agency guide, “RC4110 Employee or Self-employed?”, tells you the process that the CRA goes through in making an assessment.  They look at several elements to determine whether the responses better reflect a contract of service (employee) or a contract for service (independent contractor) for tax purposes:

1. Intention of the parties

– whether the parties intend the relationship to be one of employer / employee or independent contractor.

To decide the parties’ intentions, the CRA examines a copy of the contract and receive testimony from both the worker and the payer to ascertain the actual nature of the working relationship.

 

2. Control

Control is the ability, authority, or right of a payer to exercise control over a worker concerning the manner in which the work is done and what work will be done.  When examining the factor of control, it is necessary to focus on both the payer’s control over the worker’s daily activities and the payer’s influence over the worker.  It is the right of the payer to exercise control that is relevant, not whether the payer actually exercises that right.

Indicators of an employment relationship

  • The relationship is one of subordination. The payer will often direct, scrutinize, and effectively control many elements of how and when the work is carried out.
  • The payer controls the worker with respect to both the results of the work and the method used to do the work.
  • The payer chooses and controls the method and amount of pay. Salary negotiations may still take place in an employer-employee relationship.
  • The payer decides what jobs the worker will do.
  • The payer chooses to listen to the worker’s suggestions but has the final word.
  • The worker requires permission to work for other payers while working for this payer.
  • Where the schedule is irregular, priority on the worker’s time is an indication of control over the worker.
  • The worker receives training or direction from the payer on how to do the work. The overall work environment between the worker and the payer is one of subordination.

Indicators of an independent contractor relationship

  • A self-employed individual usually works independently.
  • The worker does not have anyone overseeing his or her activities.
  • The worker is usually free to work when and for whom he or she chooses and may provide his or her services to different payers at the same time.
  • The worker can accept or refuse work from the payer.
  • The working relationship between the payer and the worker does not present a degree of continuity, loyalty, security, subordination, or integration, all of which are generally associated with an employer-employee relationship.

 

3. Ownership of tools

– generally independent contractors provide their own tools and equipment to accomplish that work. If the payer provides a furnished office and a computer, it may point to an employment relationship.  Contractual control of, and responsibility for, an asset in a rental or lease situation is also considered under this factor.

What is relevant is the significant investment in the tools and equipment along with the cost of replacement, repair, and insurance. A worker who has made a significant investment is likely to retain a right over the use of these assets, diminishing the payer’s control over how the work is carried out. In addition, such a significant investment may place the worker at a risk of a financial loss.

Indicators of an employment relationship

  • The payer supplies most of the tools and equipment the worker needs. In addition, the payer is responsible for repair, maintenance, and insurance costs.
  • The payer retains the right of use over the tools and equipment provided to the worker.
  • The worker supplies the tools and equipment and the payer reimburses the worker for their use.

Indicators of an independent contractor relationship

  • The worker provides the tools and equipment needed for the work. In addition, the worker is responsible for the costs of repairs, insurance, and maintenance to the tools and equipment.
  • The worker has made a significant investment in the tools and equipment and the worker retains the right over the use of these assets.
  • The worker supplies his or her own workspace, is responsible for the costs to maintain it, and does substantial work from that site.

 

4. Subcontracting work or hiring assistants

Indicators of an employment relationship

  • The worker cannot hire helpers or assistants.
  • The worker does not have the ability to hire and send replacements. The worker has to do the work personally.

Indicators of an independent contractor relationship

  • The worker does not have to carry out the services personally. He or she can hire another party to either do the work or help do the work, and pays the costs for doing so.
  • The payer has no say in whom the worker hires.

 

5. Financial Risk taken by the worker

– Employees usually don’t have any financial risk as their expenses will be reimbursed, and they will not have fixed ongoing costs. Self-employed individuals may pay fixed monthly expenses even if work is not currently being done.  Both employees and self-employed may be reimbursement for business or travel expenses so they consider only expenses that are not reimbursed by the payer.

Indicators of an employment relationship

  • The worker is not usually responsible for any operating expenses.
  • Generally, the working relationship between the worker and the payer is continuous.
  • The worker is not financially liable if he or she does not fulfil the obligations of the contract.
  • The payer chooses and controls the method and amount of pay.

Indicators of an independent contractor relationship

  • The worker hires helpers to assist in the work. The worker pays the hired helpers.
  • The worker does a substantial amount of work from his or her own workspace and incurs expenses relating to the operation of that workspace.
  • The worker is hired for a specific job rather than an ongoing relationship.
  • The worker is financially liable if he or she does not fulfil the obligations of the contract.
  • The worker does not receive any protection or benefits from the payer.
  • The worker advertises and actively markets his or her services.

 

6. Responsibility for investment and management

– Is the worker required to make any investment in order to provide the services? A significant investment is evidence that a business relationship may exist.  The CRA will also consider if the worker is free to make business decisions that affect his or her profit or loss.

Indicators of an employment relationship

  • The worker has no capital investment in the payer’s business.
  • The worker does not have a business presence.

Indicators of an independent contractor relationship

  • The worker has capital investment.
  • The worker manages his or her staff.
  • The worker hires and pays individuals to help do the work.
  • The worker has established a business presence.

 

7. Opportunity for profit and risk of loss test

– employees generally don’t have an opportunity to earn profit (beyond their normal salary), nor do they risk a loss. If fewer clients come in, they generally still get a paycheque.  Contractors on the other hand, have both the opportunity for profit, and the risk of loss.  They have to pay for overhead expenses, and may not earn enough income to cover those expenses.

Self-employed individuals have the ability to pursue and accept contracts as they see fit.  They can negotiate the price (or unilaterally set their prices) for their services and have the right to offer those services to more than one payer. Self-employed individuals will normally incur expenses to carry out the terms and conditions of their contracts, and to manage those expenses to maximize net earnings.  Self-employed individuals can increase their proceeds and/or decrease their expenses in an effort to increase profit.

The method of payment may help to decide if the worker has the opportunity to make a profit or incur a loss.  In an employer-employee relationship, the worker is normally guaranteed a return for the work done and is usually paid on an hourly, daily, weekly, or similar basis.  Similarly, some self-employed individuals are paid on an hourly basis. However, when a worker is paid a flat rate for the work done, it generally indicates a business relationship, especially if the worker incurs expenses in doing the work.

Indicators of an employment relationship

  • The worker is not normally in a position to realize a business profit or loss.
  • The worker is entitled to benefit plans that are normally offered only to employees. These include registered pension plans, and group accident, health, and dental insurance plans.

Indicators of an independent contractor relationship

  • The worker can hire a substitute and the worker pays the substitute.
  • The worker is compensated by a flat fee and incurs expenses in carrying out the services.

 

Summary

Being an independent contractor as opposed to an employee takes a greater amount of risk.  There could even be times when you have little or no work.  And when the tough times come, you may be more vulnerable to your services being terminated and may be the first to be let go.  But with that greater risk comes the greater flexibility in doing the work the way you think it should be done.  As a result you might have greater job satisfaction.

You may have to invest in training to keep up-to-date and you have to secure your own benefits.  You may need to spend time marketing your services to secure new business.  And of course, being independent can result in significant tax savings.

To give up such lucrative tax status, freedom as to how you work, and be labelled as an employee, one should receive valuable training and skills development, have opportunities for advancement, and be entitled to employment benefits, paid time off and statutory holidays, and possibly accrue pension benefits.

An employee also has one additional advantage when it comes to their job coming to an end (other than for cause).  An employee will have an entitlement to severance or notice in lieu of severance.  An independent contractor has no such entitlement – their role can end at any time.

I hope that this article has been insightful to help you determine the type of role that makes best sense for you.  If you are interested in working with an investment adviser that you can talk to about your work, benefits, pensions, and quality of work life issues, then please call me, Steve Nyvik, at (604) 288-2083 Extension 2 or email me at: Steve@lycosasset.com.

Steve Nyvik

Steve Nyvik, BBA, MBA, CIM, CFP, R.F.P. WHAT I DO: Steve builds, from blue-chip dividend paying stocks and bonds, a tax efficient 'pension' designed to meet your needs through time without taking unnecessary risk. Financial planning advice and service are included to make sure that if ‘life happens to you’, your goals aren’t derailed in the process. Phone: (604) 288-2083 (extension 2) Toll Free: 1 (855) 855-9267 (extension 2) Email: Steve@lycosasset.com